Arcane Topics in Economics and Philosophy, Interspersed with Various Distractions

July 22, 2009

Things Fall Apart

President Obama is ushering in an era of politicized capitalism. Since he took office, corporate heads and business executives more and more look to Washington as the wellspring of financial success. And politicians and government officials have much to offer them: grants, loans, loan guarantees, subsidies, contracts, tax credits, regulatory and legal advantages of one kind or another over competitors, even guaranteed profits. Tempting stuff, for sure, and businesses are increasingly unable to resist. This is not a healthy trend.

The distinction here is with America's traditional system of market capitalism, which requires companies and entrepreneurs to compete in the marketplace. Except with President Franklin Roosevelt's New Deal in the 1930s and during wartime--when government officials intervened aggressively in the economy--this has been the dominant form of capitalism in America. It's allowed Americans to become the most prosperous people in the world.

The two types of capitalism exist in stark contrast in the American auto industry. General Motors and Chrysler have survived thanks to billions from the Obama administration and forgiveness of billions more in loans and other obligations. GM and Chrysler are now wards of the federal government, which picks their CEOs, names their boards, and can tell them which cars to manufacture...

Politicized capitalism comes in many forms. The Troubled Asset Relief Program (TARP) has spent hundreds of billions to stabilize banks, including some that didn't need to be bailed out. TARP funds have also gone to insurance, finance, loan, and auto companies, among others. The Federal Reserve and the Federal Deposit Insurance Corporation, while nominally independent, have followed Obama's lead and backed hundreds of billions in home loans and debt issuance. All this money--and the deference to Washington that comes with it--has reached deeply into the economy.

And Obama is eager to bring still more of the private sector under the government safety net. Big banks have paid back billions in TARP loans they received last year, but the administration has decided against using that money to reduce the deficit. Obama would rather spend it.

This was the headline of a Washington Post story on July 11: "White House Eyes Bailout Funds to Aid Small Firms." No doubt many firms would like cheap, subsidized loans from Washington, and they've begun pressing members of Congress for help in getting them. But a program of aid to small business would be a significant departure from TARP's original mandate of rescuing shaky banks.

Politicized capitalism inevitably leads to crony capitalism, the rewarding of friends and supporters with economic favors. The bailout of GM and Chrysler was a boon to the United Auto Workers, which contributed lavishly to Obama's presidential campaign. His cap and trade energy program, which has passed the House, would reward favorites of the administration and congressional Democrats with valuable allowances to emit greenhouse gases.

We have written this letter because, as Central and Eastern European (CEE) intellectuals and former policymakers, we care deeply about the future of the transatlantic relationship as well as the future quality of relations between the United States and the countries of our region. We write in our personal capacity as individuals who are friends and allies of the United States as well as committed Europeans.

Our nations are deeply indebted to the United States. Many of us know firsthand how important your support for our freedom and independence was during the dark Cold War years. U.S. engagement and support was essential for the success of our democratic transitions after the Iron Curtain fell twenty years ago. Without Washington's vision and leadership, it is doubtful that we would be in NATO and even the EU today.

We have worked to reciprocate and make this relationship a two-way street. We are Atlanticist voices within NATO and the EU. Our nations have been engaged alongside the United States in the Balkans, Iraq, and today in Afghanistan. While our contribution may at times seem modest compared to your own, it is significant when measured as a percentage of our population and GDP. Having benefited from your support for liberal democracy and liberal values in the past, we have been among your strongest supporters when it comes to promoting democracy and human rights around the world.

Twenty years after the end of the Cold War, however, we see that Central and Eastern European countries are no longer at the heart of American foreign policy. As the new Obama Administration sets its foreign-policy priorities, our region is one part of the world that Americans have largely stopped worrying about. Indeed, at times we have the impression that U.S. policy was so successful that many American officials have now concluded that our region is fixed once and for all and that they could "check the box" and move on to other more pressing strategic issues. Relations have been so close that many on both sides assume that the region's transatlantic orientation, as well as its stability and prosperity, would last forever.

That view is premature. All is not well either in our region or in the transatlantic relationship. Central and Eastern Europe is at a political crossroads and today there is a growing sense of nervousness in the region. The global economic crisis is impacting on our region and, as elsewhere, runs the risk that our societies will look inward and be less engaged with the outside world. At the same time, storm clouds are starting to gather on the foreign policy horizon. Like you, we await the results of the EU Commission's investigation on the origins of the Russo-Georgian war. But the political impact of that war on the region has already been felt. Many countries were deeply disturbed to see the Atlantic alliance stand by as Russia violated the core principles of the Helsinki Final Act, the Charter of Paris, and the territorial integrity of a country that was a member of NATO's Partnership for Peace and the Euroatlantic Partnership Council -all in the name of defending a sphere of influence on its borders.

The recession, financial crisis and two wars have pushed the federal deficit above $1 trillion, a record level that makes the Treasury secretary's role as chief marketer of U.S. debt tougher than any of his recent predecessors'.

Geithner, who traveled last week to the Middle East and Europe, has to convince foreign investors to keep buying Treasury bills, notes and bonds; they hold nearly half of the government's roughly $7 trillion in publicly traded debt.

"He's a smart guy but it's a very, very big task," said Dean Baker, co-director of the Center for Economic and Policy Research, a left-leaning Washington think tank.

If foreign demand for U.S. debt sags, that could drive up interest rates and spell big trouble for an economy hobbled by 9.5 percent unemployment. Higher rates would make it more expensive for consumers to buy homes and cars, and for businesses to finance their operations.

In the worst case scenario, a rush by foreigners to sell their U.S. debt could send the dollar crashing and inflation soaring. Because that would also hurt the value of their remaining holdings and the U.S. economy — a key market for their exports — private analysts believe such a scenario is not likely to occur.

With the risks in mind, Geithner last week visited Saudi Arabia and the United Arab Emirates, whose vast oil wealth gets recycled into Treasury holdings.

Last month, he visited China, the largest foreign holder of U.S. Treasuries. That trip was marked by an extra dose of drama. In March, Chinese Premier Wen Jiabao said his country was concerned about the "safety" of the large amounts of money it had lent to the United States.

Throughout these trips, Geithner very much stuck to his sales script, at least in his public pronouncements. He said the Obama administration was committed to guarding the value of the dollar and, once the economy improves, shrinking the deficit.

The deficit has been driven higher in part by the $787 billion economic stimulus package and $700 billion financial system bailout approved by Congress over the past year.

The deficit-cutting proposals the administration has so far revealed would fall far short of what is needed.

"If the Obama administration has a credible plan to bring the deficits down, they are keeping it a deep secret at the moment," said Michael Mussa, senior fellow at the Peterson Institute and former chief economist at the International Monetary Fund.

With nearly three months left in the budget year, the Obama administration forecasts that this year's deficit will total $1.84 trillion, more than four times the size of last year's record tally.